Drew Bernstein
Chinese Companies Continue to List in U.S., But Face Tough Sledding in 2019
Chinese companies continue to embrace the U.S. markets, but in the second half of 2019, American investors did not often return the affection.
In total, 23 Chinese companies listed on NASDAQ or NYSE in 2019 so far, representing 15% of the total IPO market. This compares to a total of 33 Chinese IPOs in 2018. According to the recent MarcumBP-Tsinghua University survey of Chinese Entrepreneurs, nearly 60% of Chinese entrepreneurs intend to add an IPO to their strategic listing plans.
Almost all of these offerings had positive first-day receptions, with an average gain of 9%. However, year-to-date, the average return of Chinese IPOs is negative 17% from the offering price, as compared to an increase of 15% for the U.S. IPO market overall. Out of the 23 new companies from China, only five were trading in positive territory as of December 10, 2019.
In addition to uncertainty regarding U.S.-China trade relations, market sentiment has been weighed down by the relative underperformance of last year’s batch of IPOs from the Middle Kingdom, many of which failed to deliver on the market’s expectations of growth and profitability. Interestingly, according to our survey, only 28% of Chinese entrepreneurs consider profitability as key to attracting investors compared to revenue growth (41%) and innovation (38%).
2018’s Chinese IPOs have sold off by an average of 38% from their IPO price, with some having lost 80-90% of their value. As a result, many companies needed to scale back their expected deal size and share price to fill the order book in the second half of 2019, with some deals led by bulge-bracket banks ending up as puny as $40 million in proceeds. The total capital raised in 2018 so far is $3.1 billion, with an average deal size of $261 million, as compared to proceeds of $7.8 billion in 2018. While this has enabled the issuers to gain public status, it leaves them with a small float that can be a significant barrier to active trading in the stock and deter institutional investor interest.
For the profitable companies, the average price-earnings ratio based on 2020 estimates is just 14.2, showing that investors remain cautious both about the economy and management teams’ ability to deliver on their promises.
The big winners from China have posted eye-popping revenue growth, such as Luckin Coffee (NASDAQ:LK), whose revenues grew 540% in the third quarter and whose stock has risen 78%. GSX Techedu (NYSE:GSX) posted revenue growth of 461% and a 73% gain in share price. When it comes to China, skyrocketing revenues still captivate investors’ attention.
When it comes to underwriters, Morgan Stanley and Credit Suisse led the pack for U.S.-China IPOs, with five deals each in the lead left position, followed by Citigroup with three. Skadden, Arps continued to have the most active franchise as company legal counsel with six IPOs, followed by Davis Polk with four.
Given the cautious sentiment, the burden is now on Chinese management to show that they can meet expectations for revenue growth and profitability. Some sectors, such as financial technology, have been subject to a high degree of regulatory uncertainty that adds to the perception of risk.
Outlook for 2020
The challenging market reception has not done anything to diminish the enthusiasm of Chinese CEOs from seeking to ring the opening bell on Wall Street.
Since September 1st, 14 Chinese companies have filed registration statements with the SEC, ranging from robot manufacturers to biotechnology companies to a drone maker and a subsidiary of Chinese insurance giant Ping-An. With contemplated deal sizes ranging from $15 to $500 million, these issuers are willing to bet that they will beat the odds.
In addition to IPOs, once there is an improvement in market sentiment, the Chinese companies that have performed are likely to launch a flood of follow-on offerings to raise additional growth capital and increase the trading liquidity in their stocks. One of the most attractive aspects of a U.S. listing is the flexibility and openness of the markets, in which a range of equity, debt, and convertible offerings can be marketed quickly at the right moment.
But to take advantage of the market window, Chinese companies will need more than luck. They will need to demonstrate that they can be successful public investments that earn investors positive returns over time.
This includes:
- Being able to meet or exceed revenue and income forecasts consistently by having mature forecasting systems.
- Demonstrate that they have a defensible moat that will preserve margins in the hyper-competitive Chinese marketplace.
- Implement mature accounting and internal control systems to be able to report timely and accurate financials.
- Be able to clearly explain their business model in a way that makes sense to overseas investors, rather than engaging in opaque disclosure or ignoring shareholder communications when they are not raising capital.
China has a vibrant venture capital and private equity market that has spawned a record number of companies with valuations north of one billion dollars in the past five years. But now the capability of Chinese management needs to catch up with the requirements of being successful as a public company. If this happens, American investors will have the opportunity to taste their part of the China dream, rather than disappointed hopes and frustrations.
